We love EMI and we recommend that it is added to the armoury of all our client companies where we can see that it might be powerful in recruiting, retaining and motivating key personnel. Now is a perfect opportunity to explain why.
The Enterprise Management Incentives (“EMI”) share option scheme was introduced, for use by qualifying trading companies, back in 2000. It was created to incentivise key employees and it has been very successful in doing so. The features and benefits, including the tax advantages in particular, are considerable; any trading companies wanting to “lock in” one or more members of staff should seriously consider its adoption.
Here is our summary of those main features and benefits, followed by an outline of how the scheme is often designed in practice. Even a “summary” is quite extensive, such are the positives, worthy of outline:
- The scheme is eligible for “full-time” individuals working within eligible trading companies/groups.
“Full-time” is not necessarily as onerous as it might sound by the way.
- The scheme is a 10 year scheme, meaning that to qualify, options must be capable of exercise within 10 years.
In our experience of designing and implementing EMI schemes, this 10 year window has so far never proved inhibiting to any prospective participant.
- The scheme is a very flexible, administration–friendly arrangement, applicable to an individual (not a class of employees) and can be designed to include (or exclude) conditions or criteria, as the employer decides.
It is perfect for tailoring to the specific needs of the specific employee and employer involved.
- The scheme benefits from an upfront valuation agreement process (i.e. agreement with HMRC as to the open market value of the option shares) which provides all parties with the opportunity to obtain tax certainty about the proposed “award” before anything is done.
This helps us to bat safely in favour of low value, if that is sustainable and desired, and in the writer’s experience, HMRC are often cooperative with our valuation proposals, possibly because they may be encouraged to help facilitate employee participation.
- The scheme involves no tax at all upon grant of the share options.
- The scheme involves no tax at all upon exercise of the share options, as long as the exercise price (aka option price) payable by the employee is not less than the agreed open market value at the date of grant.
This explains why a cooperative advance agreement per 4 above can be so valuable.
- Tax only arises upon ultimate disposal for the option shares and all of that will be on a CGT basis, assuming 6 above applies.
Furthermore, the CGT rate will be the 10% Entrepreneurs’ Relief rate, irrespective of the size of holding or the length of time the shares have been held (as long as the grant of the options took place at least two years prior).
This also means that the EMI scheme can be designed to allow option holders to exercise their options immediately before a sale (or other transfer of control) of the company, without them losing access to the 10% rate of CGT. (See “Exit-driven schemes” below.)
- At the same time as the option holder’s gain on sale (per 7 above) suffers tax at 10%, an amount equal to that gain (i.e. the increase in value from the original date of grant through to the date of exercise) fails to be deducted from taxable profits for the employer company.
Yes, surprising as it may seem, the company is eligible for a CT deduction equivalent to the employee’s gain in these circumstances. A very useful injection of extra value at the time of a sale.
For all of the above reasons, in particular, EMI can be very powerful. We know from experience that key employees like it and that it works. Those key employees know that their efforts are contributing to capital value, some of which will be theirs to enjoy, of course.
Exit-driven schemes (and other solutions)
In a lot of cases, the EMI schemes we design and implement are what we refer to as “exit-driven” schemes. That is to say the schemes are organised in such a way as the options are exercisable immediately prior to a sale or other transfer of control of the company.
This can suit many employers who may not want any minority shareholders in place during their time in ownership. It can also suit the option-holders because it means they won’t have to stump up the option price early on. Indeed they will typically receive proceeds on sale of the shares which provides the money with which to pay for the very shares sold!
If an option-holder might have cause to fear that an “exit-driven” arrangement could leave him or her empty-handed (eg because a sale might not happen within 10 years) the scheme might provide for a long-stop date allowing the option holder to exercise after 9 years and 11 months (say) to provide reassurance that the proposition is real.
There are, in addition, sometimes very good reasons for allowing much earlier exercise of these options (e.g. access to dividend income in lieu of bonuses, perhaps).
Each case is different, warranting bespoke design to maximise the advantages in the context of the specific circumstances and objectives involved. If you are interested in exploring further the merits of EMI for your company and its key personnel, please get in touch.